Which investment does 145 years of data prove to be better?
Every asset class and company has their reasons for why they are unequivocally the correct choice for investors. In an environment like this, it is natural to become distrustful and overwhelmed.
One of the toughest things to do in the investing world is separate fact from fiction.
So what should you do? Your best bet is looking at third-party data. Doing so eliminates much of the bias you find from those standing to profit off of you and allows you to make the best decisions for your future.
The Rate of Return on Everything
You don’t have to sift through massive amounts of data to come to valuable conclusions. Researchers have done it for us in the famous “The Rate of Return on Everything” paper. The basis of the study is a simple question: Which investment has yielded the highest returns over the past 145 years?
To answer this popular question, researchers analyzed 16 countries and used a variety of mathematical techniques to normalize data over time. What they found was a winner, a close second, and two more classes bringing up the rear.
Their returns rates are as follows:
Real Estate – 7.05%
Equities – 6.89%
Bonds – 2.5%
Treasury Bills – 0.98%
The Risk Vs. Reward Trend
Financial analysts often speak in cliches. One of the most common is higher risk investments lead to higher returns. If you look at our bottom three assets, you see this trend take form.
The lowest return is the treasury bill, with almost no risk associated. A step up bonds, providing a slightly higher return percentage. Lastly, we have equities gaining much more than the other two over long periods but presenting with a significant amount of downside.
Fortunately, you don’t have to crunch the numbers yourself to understand risk and reward. Nobel Memorial Prize winner, William Sharpe, created a system that does just that. The resulting value is called the Sharpe ratio. The way it works is that a higher number signals a better investment.
The following are ratios for three of the assets discussed above:
Real Estate – 0.7
Equities – 0.27
Bonds – 0.2
The result is clear: Real estate is a much smarter investment than any of its competition. But, what does this mean in the real world?
Real Estate: The Best of Both Worlds
Now, let’s talk about why real estate is such an excellent investment without complex ratios. It comes down to two factors.
First, real estate has the highest returns because it generates income and also experiences appreciation. This effect gives you consistent passive income throughout your investment and allows you to sell for more than your purchase price if you choose to do so.
Second, the risk is low. Investors generally expect to be subjected to elevated risk for the gain of higher returns. While that idea applies equities, it doesn’t apply to real estate.
Real estate is one of the safest investments.
A few factors contributing to this effect are income generation, appreciation, consistent demand, and inflation resistance. Ultimately, the reason real estate is the best of both worlds is it has incredibly high returns and surprisingly low risk.
What It All Means For You
The conclusion of the data is quite clear. Real estate is the most secure investment option, with all other assets coming up short. The next logical thought is whether or not you should put all of your money into real estate. The answer to that question will depend on your financial goals, but it is likely a no.
The following are a few reasons why:
Diversity: Though real estate is incredibly safe; you still might want to diversify your investments with other types of assets. In theory, doing so will make your portfolio more resilient.
Capital: If you have a relatively small amount of money to invest, you might find the barrier to real estate too high. One way to avoid this hurdle is through private real estate investment funds.
Investment Length: You might invest a chunk of money with the intent of using it in just a few years. In this case, you would likely opt for a more liquid asset with little to no risk associated.
While you may want to diversify with other assets, the most prudent way to grow your portfolio with low risk and high returns is to prioritize real estate as your highest allocation. Real estate allows you to build streams of passive income that will enable you to create generational wealth.
When in doubt, trust hard data from third parties over the marketing teams at various investment companies. The data doesn’t lie.